Fed’s Kocherlakota surprises with dovish stance

WASHINGTON (MarketWatch) — A senior Federal Reserve official thought to be in the hawkish camp surprised Fed watchers Thursday by suggesting the central bank can keep rates low until the unemployment rate falls below 5.5% as long as inflation stays stable.

In a speech in Ironwood, Mich., Kocherlakota remarked that the Fed would be satisfying its stable-inflation mandate as long as its outlook for inflation over the next two years is between 1.75% and 2.25%, and longer-term inflation expectations are stable.

He noted that the medium-term outlook for inflation has not risen above that level for 15 years.

The new “liftoff plan,” Kocherlakota said, was an alternative to the proposal from Charles Evans, president of the Chicago Fed Bank, in which the central bank would commit to keeping rates exceptionally low until unemployment falls below 7%, only stopping if inflation rises to 3%.

Kocherlakota also said he doubted that the Fed could stimulate the economy by tolerating higher inflation. Many households would only save more if inflation increased because of worries that their wages would not keep up with higher prices.

Fed watchers noted that, only in April, Kocherlakota said the central bank might have to raise rates by the end of the year.

“It is perplexing. He has gone from suggesting that rates needed to rise six to nine months down to the road to saying that 39 months from now we can still stand pat,” said Lou Crandall, chief economist at Wrightson ICAP.

David Greenhaus, chief global strategist at BTIC LLC, said Kocherlakota’s shift suggests “the shift on the Federal Open Market Committee has been pretty dramatic.”

The Fed’s short-term federal funds rate policy tool has been stuck at zero to 0.25% since December 2008.

Last week the Fed pushed out the date when it expects to have to exit until mid-2015 from its prior guidance of late-2014.

The central bank also announced a third round of asset purchases, $40 billion per-month of mortgage-backed securities, in a plan that is open-ended, or, in other words, with no end date.

Before Kocherlakota spoke, the flood of speeches and interviews of Federal Reserve speakers this week had only highlighted the existing divide between policy-makers about QE3, said Stephen Stanley, chief economist at Pierpont Securities.

“The only thing we’re learning is that the incredibly wide divide between hawks and doves has gotten wider,” said Stanley.

“I don’t think there is personal animus but the disagreement is so wide, they have decided to agree to disagree and move on,” he said.

Laurence Meyer, a former Fed governor and now prominent Fed watcher, said he had never seen the central bank so divided.

Asked about divisions among Fed officials at his press conference, Fed Chief Ben Bernanke downplayed any tension and noted that the QE3 program was approved by an 11-to-1 vote.

But that vote total is a bit “deceptive,” Stanley said. The Fed’s voting committee is stacked with doves this year. And there is a high bar for Fed governors to dissent.

Four regional Fed presidents, who were not voting members of the Fed’s interest-rate setting committee, would likely have voted against further bond buying, he said.

In Fed shorthand, hawks are more focused on inflation, while doves are more supportive of efforts to lower unemployment.

The crux of the argument at the moment is that the doves on the Fed believe the sluggish economy is suffering from a lack of demand, something Fed policy can impact, Stanley said.

On Thursday, Eric Rosengren, the president of the Boston Fed, said the Fed’s third round of asset purchases was a “forceful” action to help the U.S. avoid a “Great Stagnation.”

Hawks believe the impediments are not on the demand side and are therefore not subject to classic Fed stimulus.

So they don’t believe more easing is likely to help much and could create higher inflation down the road.

Doves note that inflation has stayed low over the past four years when the Fed bond-buying programs started.

“While [inflation] is a concern and we have to be watchful for it, I don’t put much weight on the fact that we’re going to see much inflationary pressures over the next several years,” Rosengren said in an interview with the Fox Business Network.

Also on Thursday, Dennis Lockhart, the president of the Atlanta Fed, said the Fed’s latest stimulus would help the economy and called the chances of a serious outbreak of inflation “remote.”

In the end, Green of TD Securities said Fed speeches should be treated as “an interesting side-show and nothing more.”

“Bernanke rules the FOMC with an iron first, not unlike [former Fed chairman] Greenspan once did, even if the popular perception is to the contrary,” Green said.

Intraday Data provided by SIX Financial Information and subject to terms of use. Historical and current end-of-day data provided by SIX Financial Information. All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only. Intraday data delayed at least 15 minutes or per exchange requirements.